Will You Buy the Facebook of China?

It's another hot IPO!

With the market on the rebound, the hot IPOs keep coming. Since I took the space last week to tell you about one that is definitely worth your interest, I thought I would use it this week to warn you about one that is definitely not. The company that's in that latter category is Renren, the soon-to-be-public-on-the-NYSE Internet company that the media likes to call the "Facebook of China."

While Renren and Facebook do share a number of similarities -- both are real-name social networking sites, for example -- what they have most in common is eye-popping valuations. For Facebook, that's an outlandish $78 billion as of March. For Renren, it's almost $4.4 billion -- a somewhat smaller, but still outlandish amount.

There are, however, some potential reasons to get excited about the chance to own a piece of Renren. With some 400 million Internet users, China is already the world's largest Internet market -- and that's despite the fact that only 30% of the population is online. Furthermore, fewer Chinese Internet users engage in social networking than their global peers, making this a space ripe for hyper-growth. Finally, while Renren is not quite engaging users as well as Facebook, it's close -- with the average user spending 15 minutes on the site.

But before you get too excited about the market opportunity and set your alarm for the May 4 IPO date, there are a few things you should know about Renren …

Buyer bewareFirst, if you buy shares of the Cayman Islands-based holding company, you don't actually own the operating company in China. That company, Beijing Qianxiang Tiancheng Technology Development, will remain 99% owned by Renren CEO Joe Chen's wife, Jing Yang (a Chinese citizen). There will be a contract in place that entitles you, a foreign shareholder, to the economic benefits of the company. That may sound like a neat way to circumvent Chinese restrictions on foreign ownership of telecommunication assets, but good luck getting that contract enforced in Chinese court should Ms. Yang choose not to honor it. Further, a dual-class share structure that limits the influence of outside shareholders means that Joe Chen and his wife hold all of the cards here.

Second, unlike Facebook here in the U.S., Renren is not the clear leader in the social networking space in China. There are a number of competitors, including two backed by cash-rich Chinese Internet giant Tencent.

Third, while Joe Chen is often called the "founder" of Renren, he's not actually the heart and soul of the technology like Bill Gates was at Microsoft or Mark Zuckerberg at Facebook. These zealots spearheaded years of innovation at their respective companies and earned early investors incredible returns in the process. Rather, Chen acquired the platform from some Chinese college students in 2006. As Kai Lukoff reported at Mashable, it's actually competitor kaixin101.com that has the innovative founder.

Finally, know that the reason Facebook isn't the Facebook of China is because the site is blocked there by Chinese government censors. Recently, however, it's been rumored that Facebook is looking to team up with Chinese search giant Baidu(Nasdaq: BIDU) to launch a new social networking service in China. Having such an influential local partner might help Facebook make inroads in China and would undoubtedly be a massive threat to Renren's long-term position.

In light of these factsIt bears repeating that the proposed valuation here is truly ridiculous. According to its registration statement, Renren earned $11.1 million in EBITDA from advertising and gaming revenue of $76.5 million. Buying shares at the IPO, then, would have you paying 57 times sales and 396 times EBITDA. See how that compares with other high-growth and solidly profitable emerging market tech businesses:

About the only company Renren looks cheap next to is another recent China Internet IPO -- Youku.com(Nasdaq: YOKU). That's because Youku, the "YouTube of China" is even more of a story stock and even worse at making money.

The global viewThe bottom line is that if you're going to pay up for Renren, you need to believe in at least three realities. First, that Renren will be the dominant social networking site in China in 10 to 20 years. Second, that Renren will have figured out more and better ways to monetize its traffic. Third, that foreign shareholders of Renren will end up benefiting from its success.

While all three of those are open questions in my mind, the most challenging for me is believing Renren will end up king of China's social networking hill. It's not there now, it's not run by the most innovative team, and more and more competition is coming. That's why investors should pass on this IPO.